Bank Of America Preferreds Currently Preferable To Common Stock

Many have been saying how Warren Buffett got a sweetheart deal on Bank of America (NYSE:BAC), and he clearly did. He will be enjoying a nice 6% yield each year and get a 6% premium if BAC decides to call the preferreds. It's not unheard of to get a better yield than him though.

Currently, you can buy Bank of America Series H preferred, which yields about 8.7% and is trading a few bucks under par. So you might be excited to see that you get a much better yield than Warren Buffett. However, it's not necessarily that simple and I will explain why.

When investing in a tradition preferred stock, you should know there are two types. One is cumulative and the other is non-cumulative. Cumulative preferreds mean that a company basically cannot stop payment to the holders and if it were to it would have to stop paying the dividend for the common until the holders receive all dividend payments. Companies have no obligation to non-cumulative holders, they could stop payment indefinitely.

Warren Buffett is getting 6% on cumulative preferred shares. In addition, his preferreds can be converted to regular shares at a price 7.14. We could buy non-cumulative shares and get nearly 9%, but the risk comes in the obligation. Bank of American could stop payment any time if they wanted.

I honestly do not believe that BAC would do this as it would signal a massive negative reaction to the market. I think BAC will be fine long-term and continue its plan to build up liquidity. Holders of preferred shares shouldn't be as worried as common shareholders. The common stock could continue to languish for a long time. That's why I like the preferred stock, where you get a nice dividend and get to buy it for under par value.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.